question archive To settle a $770 invoice, Anna can pay $760 now or the full amount 45 days later
Subject:FinancePrice:2.86 Bought11
To settle a $770 invoice, Anna can pay $760 now or the full amount 45 days later.
a. Which alternative should she choose if money can earn 9 3/4%
multiple choice
a - Pay $760 now
b - Pay full amount 45 days later
b. What rate would money have to earn for Anna to be indifferent between the alternatives? (Use 365 days a year. Do not round intermediate calculations and round your final answer to 2 decimal places.) Rate ______ %
Invoice Value = $770
Value if Paid today = $760
Value if Paid after 45 Days = $770
No. of Credit Days = 45
No. of Days in a Year = 365
Rate of Interest = 9.75%
Effective Cost of Trade Credit = (Invoice Value / Value if paid today)(No. of Days in a Year / No. of Credit Days) - 1
Effective Cost of Trade Credit = (770 / 760)(365 / 45) - 1
Effective Cost of Trade Credit = 11.19%
Thus, effective return if the discount option is chosen by us is 11.19%.
a)
Since, the effective return of discount option > return on investment
i.e. 11.19% > 9.75%,
we should choose the discount option as we would get more return over there.
Thus, we should pay now. Thus, option (a) i.e. Pay $760 now.
b)
Money should earn a rate of return of 11.19%, to be indifferent between the 2 options.